Why Builders and Contractors need to do Cost Value Reconciliation?

Cost Value Reconciliation and Cost Value Comparisons are used on construction projects, they are essential if you want to keep project on budget and report costs and revenue correctly.

The CVR not only looks at costs to date and sales revenue to date but also brings in committed costs, forecasts, contingencies, scope changes, stage of completion and forecasts.

There are two types of Revenue Valuation, Internal (for use with the CVR) and External (application for payment), what gets certified with the client is unlikely to be the true internal value. There may also be items disputed with the client.

The CVR then results in adjustments to both Revenue and Costs to give a true reflection of Profitability.

Costs should not be under estimated and Revenue should not be over estimated within the CVR.

The CVR is great tool to highlight spend issues early on and take action with the client to keep within budget.

Here is an example CVR from the Template Store Cost report template (online-templatestore.com)

The case of Mark Smith v HMRC [2012] TC02321

The appellant in this case was trading as a builder who provided ground works for construction companies. He had an in house surveyor who produced his applications for payment, the clients surveyor certified the valuation within 3 weeks and the accountant recognised the value when certified. The contracts were fixed price and lasted up to 12 months, The business started as a Sole Trader and was subsequently incorporated.

HMRC opened an enquiry in 2001/2002.

The central issue before the tribunal related to the appellant’s computation of profits. It was admitted that his accounts understated the profits gained in a particular tax year. However, it was his contention that this was a “one-off”.

The tribunal held that HMRC’s assessments were in fact justified.

The reason why HMRC were successful was that in the case of Mark Smith he based his income on certified revenue, this meant that the profit was understated, within Construction “UK GAAP” requires revenue to be reported on application based on the CVR matching approach.

The details of the additional profits and tax for each year are as follows:

(1)2000/01: additional profits of £43,189 giving rise to tax of £17,275.60

(2)2001/02: additional profits of £65,205 giving rise to tax of £24,972.02

(3)2002/03: additional profits of £73,889 giving rise to tax of £27,737.86

(4)2003/04:additional profits of £70,023 giving rise to tax of £27,503.41

(5)2004/05: additional profits of £70,000 giving rise to tax of 27,704.18

(6)2005/06: additional profits of £65,240 giving rise to tax of £26,735.44

(7)2006/07: additional profits of £45,541 giving rise to tax of £18,671.81

Further guidance is in UITF40 which came in 2005 and basically stated revenue should be reported in line with work completed by the seller.

Under the principle of matching costs and revenue should be aligned.

steve@bicknells.net

When should you recognise revenue on services provided?

The International Accounting Standard IAS 18 states

‘where the outcome of a transaction involving the rendering of services can be estimated reliably, associated revenue should be recognised by reference to the stage of completion of the transaction at the end of the reporting period’ . In other words, the revenue is recognised gradually, rather than all at one ‘critical point’, as is the case for revenue from the sale of goods. IAS 18 further states that the outcome of a transaction can be estimated reliably when all the following conditions are satisfied:

(a) The amount of revenue can be measured reliably.
(b) It is probable that the economic benefits associated with the transaction will flow to the seller.
(c) The stage of completion of the transaction at the end of the reporting period can be measured reliably.
(d) The costs incurred to date for the transaction and the costs to complete the transaction can be measured reliably.

IAS 18 does not prescribe one single method that should be used for determining the stage of completion of a service transaction. However the standard does provide some examples of suitable methods:
(a) Surveys of work performed.
(b) Services performed to date as a percentage of total services to be performed.
(c) The proportion that costs incurred to date bear to the estimated total costs of the transaction.

If it is not possible to reliably measure the outcome of a transaction involving the provision of services (perhaps because the transaction is in its very early stages) then revenue should be recognised only to the extent of costs incurred by the seller, assuming these costs are recoverable from the buyer.

In the UK UITF40 and SSAP9 defined the way we report revenue and profit in relation to Services, although accountants and lawyers were among the most high profile casualties of the new regime back in 2005, which forced them to re-catagorise WIP and Revenue, many other service providers also had to consider how they accounted for income. Professionals such as surveyors, architects, doctors and dentists all had to consider the impact of the new rules on their tax liabilities.

FRS102 has not changed the rules.

steve@bicknells.net

Should my Work in Progress be classified as a Debtor (UITF40)

It’s a common issue and area of confusion and it has tax implications. WIP is valued at the lower of cost or net realisable value but Debtors whether invoiced or not are valued at Sales Value, uninvoiced Sales are shown as Amounts Recoverable on Contracts within Debtors.

Here is an example from HMRC

A joiner contracts to create fitted bookcases in an office for a total price of £15,000. He purchases the timber (materials cost £6,000) and builds the doors in his workshop. He also prepares the timber for the rest of the structure in his workshop. He then builds the skeleton of the bookcases on the customer’s premises and attaches thereto the timber that he has already prepared in his workshop. What is the accounts treatment if his year end occurs after he has prepared the timber and the doors but before he has gone to the customer’s premises to build the skeleton and fit them?

The contract is a single contract and the joiner should recognise revenue according to the stage of completion of the work. It is not relevant whether the work is done at his workshop or at the client’s premises. Neither is it relevant that part of the contract can be regarded as ‘goods’ and part as ‘services’: both are treated in the same way for accounting purposes.

Let us assume the joiner assesses that he has done 1/3 of the work by the year end and he has used half of the timber and other materials. The calculation would be: total price £15,000 less materials at cost (£6,000) leaves £9,000. Assuming the profit attaches only to the labour, accrued income is £3,000 (1/3 complete) plus materials at cost of £3,000 ( a half used), a total of £6,000. The remaining half of the total cost of the materials (£3,000) is work in progress. These figures should then be adjusted to reflect any likely losses, discounts, delay in payment or cost of difficulties expected to arise in completing the contract. Any progress payments received should be treated as creditors in accordance with SSAP 9.

http://www.hmrc.gov.uk/manuals/bimmanual/bim74270.htm

Also further guidance at

http://www.hmrc.gov.uk/helpsheets/hs238.pdf

http://www.icaew.com/en/technical/tax/tax-faculty/~/media/Files/Technical/Tax/Tax%20news/TaxGuides/TAXGUIDE-8-06-UITF-40-and-Taxation.ashx

So do you have Work in Progress or Amounts Recoverable on Contracts?

steve@bicknells.net